TYPES OF ANALYSIS
Technical Analysis refers to the future forecasting of financial markets, be it price movements in stocks, commodities, or currency movements, based on a series of previous price movements. Similar to weather forecasting, the technical analysis is only a prediction and does not provide the exact price level for the future. It is more of a 'likely' situation than a 'surely' situation over the foreseeable future and is done by a wide range of charts that depict price movements over time.
The very popularly known, Charles Dow, laid the foundations for the modern technical analysis. Of the various theorems put forward by him, the three most prominent are:
Price Discounts Everything
This theorem represents the strong and semi-strong forms of market efficiencies. According to technical analysts, the current price of any asset or currency reflects all information available; hence, the current price is representative of the fair value and should, therefore, form the base for analysis. The market price is after all affected by the accumulated information of the sentiments of investors, hedge funds, banks, traders, portfolio managers, buy-side analysts, sell-side analysts, market strategist, technical analysts, fundamental analysts, insiders, and many others. So the idea with the technical analysis is that the price of an asset carries enough information for people to trade.
Prices Movements are not Random
Although market participants agree that prices and the mood of investors tend to be random, they also exhibit some patterns, such as markets will trend in one direction or be trapped in a price range. Traders will also buy at levels they have bought in the past, and sell at prices where they have sold in the past, these levels will be clearly visible on the chart and could be used to formulate new trades.
“What is,” is more important than “Why”
Because the price of a currency will discount everything, the idea of TA traders is that it is not necessary for the technical analysts to know exactly why the price is rising or declining. What is important is “what is happening” e.g., the market is trending or trading sideways, instead of why it is happening.
Fundamental analysis is a more conventional way of trading markets and trying to predict the future of FX prices. It encircles the impact of global economic events that could affect financial markets, which include major economic data releases, political situations, company earnings, central bank policy meetings or any broad-based announcement by any influential organization, to name a few.
The idea behind such a conventional technique is that if a country is economically performing well, the respective domestic currency should strengthen and vice versa. This is because the economic health of any country determines the flow of foreign investment (FDI) and businesses, and this means foreigners must buy a country’s currency to invest or start a business there.
Say for example, if that the Eurozone economy is doing good, the Euro (EUR) will be in a position to strengthen because of higher demand in the market, relative to other currencies. In response to robust growth expansion as well as strong inflation, the central bank will typically hike their key interest rate to dampen growth and inflation. Higher interest rates tend to attract to foreign traders and investors, and as a result, they will buy the Euro (EUR) to take advantage of the relatively higher interest rates in the Eurozone.
Major economic events in Forex
We will now cover some of the most important economic events that drive Forex price movements. These are day-to-day concepts that are commonly used and need to be known by Forex traders.
Gross Domestic Product (GDP)
The GDP is one the most important and broadest economic indicators that measure the economic performance of a country. It is in fact, the apex measure of any country’s performance. The U.S. GDP report is published at 8:30 am EST on the last day of each quarter, and it reflects the prior quarter’s economic activity. By definition, it is the aggregate monetary value of all the goods and services produced within the domestic geographical boundary of an economy during the quarter being measured. The growth rate of GDP is what traders watch, and they use it to compare one country versues another.
It is the measure of the difference between the country’s exports and imports of tangible goods and services. If any country such as Japan or the U.S. exports more goods than they import, then this tends to lift the countries currency and vice versa.
Higher exports than imports indicate trade surplus and trade deficit, otherwise.
Consumer Price Index (CPI), Inflation
It is the change in the cost of a bundle of consumer goods and services on a monthly basis and is the most widely used and trusted source of measuring the country’s inflationary trends. The U.S. inflation report tends to be published at 8:30 am EST around the 15th of each month, and it shows how much inflation has risen per month and per year in the prior month. The inflation report is important for a currency as inflation is something that a central bank tries to control, by manipulating interest rates and the supply of money.
Employment Indicators, e.g., U.S. Non-Farm Payrolls (NFPs)
This includes all data related to the labor market with the unemployment rate being the most important metric to determine the health of a country and future inflation pressure. In the same report, traders, watch the number of new jobs created, and labor market inflation such as “U.S. average hourly earnings”, or wages
Forex markets are primarily driven by interest rates differentials between countries and are therefore closely watched by all market participants. As an example, if the interest rate at bank A is at 10%, and the interest rate bank B is at 5%, then it is likely that traders will prefer to deposit their money with bank A over bank B if it is just the interest rates that set the banks apart. The same logic applies in Forex trading; traders will invest in high yielding currencies by borrowing in low yielding currencies, this sort of trading strategy is called the Carry Trade.
Put in most simple words, market sentiment is the feeling or speculations that investors have while trading in the financial markets about a particular asset or financial instrument.
History has shown that when the market is trending, retail traders tend to skew against the trend. This means that if the trend is upwards, retail traders try to be net-short in the market. While, if the market is trending downwards, traders tend to be net-long. The sentiment indicator is thus, a useful tool to validate trends and breakouts in the financial markets.
On the other hand, when the market is range bound on a daily basis, then retail traders tend to get it right. This means that if the market is range bound and the price is hovering near a major resistance level, and traders turn net-short, then this tends to point towards a price decline.